4 Methodology

4.1 MCEV components for covered business

Net asset value (NAV)
The net asset value is the market value of assets allocated to the covered business, which are not
backing liabilities from the covered business.

The net asset value is calculated as the statutory equity capital, adjusted by the unrealised gains
or losses on assets covering the equity capital that are attributable to shareholders after taxes.
Depending on local regulatory restrictions, equalisation reserves are also included in the net asset
value. Intangible assets are not accounted for in the net asset value.

The net asset value is further split between the required capital (RC) and the free surplus (FS).

Required capital (RC)
The required capital is the market value of assets, attributed to the covered business – over and
above that required to back liabilities for covered business – whose distribution to shareholders
is restricted. As in prior years Swiss Life bases the amount of required capital on 150% of the level
according to Solvency I, except for assumed external reinsurance where an economic approach is
used instead.

The amount of required capital disclosed is presented from a shareholder’s perspective and thus is
net of funding sources other than shareholder resources (such as subordinated loans or unallocated
bonus reserves).

Free surplus (FS)
The free surplus is the market value of assets allocated to, but not required to support, the in-force
covered business at the valuation date. The free surplus is calculated as the difference between
the net asset value and the required capital.

Under the chosen definition of required capital, the free surplus, unlike the required capital, is
supposed to be immediately releasable and hence does not affect the frictional costs of required
capital.

Value of in-force business (VIF)
The value of in-force business consists of the following components:

Certainty equivalent value (CEV)

Time value of financial options and guarantees (TVOG), including the cost of credit risk
(see below)

Cost of residual non-hedgeable risks (CNHR)

Frictional costs of required capital (FC)

In the MCEV Principles, the term present value of future profits (PVFP) is used instead of certainty
equivalent value.

Certainty equivalent value and time value of financial options and guarantees are items that
involve projections encompassing local statutory liabilities and assets in line with:

local legal and regulatory obligations

company practice due to commercial and competitive constraints

local market practice in the calculation of embedded value

Certainty equivalent value (CEV)
The certainty equivalent value is defined as the present value of the future shareholders’ statutory
profits (net of tax) under the certainty equivalent scenario.

In this particular scenario, future market returns are determined as the forward rates implied in
the reference rates at the valuation date. Discounting is performed at the same reference rates.
The certainty equivalent value includes that part of the value of financial options and guarantees
which materialises in the underlying scenario.

The rules for anticipated management and policyholders’ actions applied in the certainty equivalent
scenario are the same as those for the stochastic projection used to determine the time value
of financial options and guarantees.

Time value of financial options and guarantees (TVOG)
The certainty equivalent value does not allow for the risk that the financial outcome for shareholders
could differ from the one implied by the certainty equivalent scenario. This is of particular
relevance when products or funds include guarantees or options for the policyholder such as:

For such products or funds, a stochastic projection has been run allowing for the range of possible
scenarios for financial markets. The TVOG is calculated as the difference between the average
present value of shareholder cash flows (profits or losses) and the certainty equivalent value, plus
the cost for credit risk (see remarks on credit risk below). The TVOG therefore represents the
additional market consistent value of those financial options and guarantees in excess of the
intrinsic value which are already allowed for in the certainty equivalent value.

At the end of the projection, shareholders are assumed to meet any shortfall of assets against
liabilities or to receive a share of any residual assets. The same applies to the certainty equivalent
value.

The cost of credit risk accounts for the shareholder’s share of credit risk of investments in bonds
that would have otherwise been unaccounted for in other MCEV components. It is defined as the
present value of charges on the projected economic capital for credit risk.

The economic capital for cost of credit risk has been projected based on mathematical reserves.
An annual charge of 4% has been applied to the resulting projected economic capital.

Cost of residual non-hedgeable risks (CNHR)
The cost of residual non-hedgeable risks for risk factors such as mortality, morbidity, expenses
and lapse rates is calculated under a cost of capital approach. It is defined as the present value of
annual charges on the projected economic capital for residual non-hedgeable risks.

The initial capital for the CNHR has been calculated in line with Swiss Life’s internal model. The
corresponding economic capital is calculated by aggregating the stand-alone economic capital
amounts that correspond to non-hedgeable risk factors, notably the following:

mortality

longevity

disability/morbidity

recovery rates

capital options

lapses

expenses

The drivers for projecting the economic capital for CNHR are generally based on the statutory
solvency margin.

An annual charge of 4% has been applied to the resulting projected capital at risk. It represents
the excess return or risk premium that a shareholder might expect on capital exposed to nonhedgeable
risks.

In order to be consistent with the CFO Forum Principles, no diversification between hedgeable
and non-hedgeable risks has been taken into account. Furthermore, no diversification effects
between market units have been accounted for.

Frictional costs of required capital (FC)
The frictional costs of required capital for the covered business are defined as the present value
of the costs incurred by shareholders due to investment via the structure of an insurance company
(compared to direct investment as individuals), such as tax on profits generated by the insurance
company or the costs of asset management. Other potential frictional costs such as agency costs
or financial distress costs have not been taken into account in the frictional costs of required
capital.

4.2 New business

New business is defined as covered business arising from the sale of new contracts and from new
covers to existing contracts during the reporting year, including cash flows arising from the
projected renewal of those new contracts. Higher premiums in Swiss group life contracts from
wage increases are not considered new business. The value of new business (VNB) reflects the
additional value to shareholders created through the activity of writing new business during the
reporting period.

The value of new business of a period represents the effect on the MCEV as at end of period from
writing new business, i.e. it is the difference between the actual closing MCEV and the closing
MCEV which would result if no new business had been written during the period. This is known
as the “marginal” approach to value of new business. It applies to every MCEV component: CEV,
TVOG, CNHR and FC. Legal constraints – e.g. “legal quotes” – or management rules often apply
to books of contracts as a whole instead of individual contracts. That is why the value of new
business can be dependent on the business in force before the writing of new business.

A “stand-alone” valuation for value of new business has been performed when the business in
force is not affected by writing new business (for example for unit-linked contracts). In this case,
the value of new business has been valued independently of the business in force.

The value of new business is generally calculated with economic scenarios and assumptions as at
end of period.

4.3 Asset and liability data

All assets and liabilities reflect the actual positions as at valuation date.

Assets
The asset model used for the calculation of the MCEV differentiates three main asset classes:

cash and fixed income instruments

equity-type investments (including real estate)

derivatives

All bonds and bond-like securities (such as mortgages) are modelled as fixed or floating government
bonds. For all bonds, coupons and nominals have been recalibrated so that the valuation of the
bonds using the reference yields converges to the observed market value.

Current initial market values of assets have been taken where available (“marked-to-market”), or
estimated where there is no reliable market (“marked-to-model”), for example by discounting
unquoted loan and mortgage asset proceeds. Local regulatory and accounting frameworks (such
as the amortisation of bonds or lower of cost or market principle) are reflected.

When a substantial share of the assets is held in foreign currencies, these foreign assets are modelled
explicitly (including the foreign currency exchange risk).

Insurance liabilities
Liabilities are valued in line with local statutory requirements generally using individual policy
data. For projection purposes, policies of the same product with similar risk profiles are grouped
together to form model points.

Hybrid debt
In accordance with the MCEV Principles (G3.4), hybrid debt allocated to covered business is
valued by discounting the corresponding coupon and nominal payments (liability cash flows)
with reference interest rates and spreads that would be used by capital markets for debt with
similar characteristics. For the spread used, see section 5.1.1.

4.4 Economic scenario generator

The MCEV is calculated using a risk-neutral valuation, based on market consistent and arbitragefree
stochastic economic scenarios. Under this approach, the key economic assumptions are:

the reference rates

interest rate and equity-type volatilities

correlations between the economic risk factors

inflation rates

The stochastic economic scenarios are generated by the economic scenario generator developed
and provided by Barrie & Hibbert, part of Moody’s Analytics, Inc. For variable annuity products
a dedicated economic scenario generator is used.

The assets and liabilities within the Swiss Life Group are mostly denominated in Swiss francs,
euros or US dollars. The economic scenarios reflect these three major economies, and also British
pounds and Canadian dollars, which are of lesser importance. The exchange rates and dividend
yields are modelled as additional risk factors, as well as the inflation rates in each economy.

For the calculation of the MCEV and the value of the new business as at valuation date, 2000 economic
scenarios are used, ensuring convergence of the results for all market units. For the
calculation of the sensitivities and some steps in the movement analysis, some market units use
fewer scenarios in connection with variance reduction techniques.

4.5 Dynamic management actions and policyholder behaviour

Anticipated dynamic management actions and policyholder behaviour mainly concern the
following areas: profit-sharing for participating life businesses, asset allocation and realisation
of gains and losses, and assumed policyholder behaviour with regards to their contractual options.
They are dependent on the economic scenario considered and reflect local regulations and type
of business.

The crediting rules for policyholders are consistent with current company practices and local
regulatory and legal requirements, in particular regarding the existence of a “legal quote”.

The rules for future asset allocations are consistent with going-concern assumptions. Asset
realignment avoids deviating from the strategic asset allocation by more than a predefined margin
and takes place after each projected year.

Lapse rates from policyholders have been dynamically modelled. For traditional business, lapse
rates depend on the difference between the credited rate to the policyholders and the anticipated
policyholders’ expectations. Lapse parameters depend on the country and product line considered.

4.6 Look-through principle

MCEV guidance requires that profits or losses incurred in service companies from managing
covered business are measured on a “look-through” basis. This principle ensures that all profits
and losses incurred in relation to the covered business are passed to the corresponding entity,
and consequently incorporated into the value of in-force business.

The look-through principle is applied for asset management services and corporate centre services.
The future profits or losses taken into account for these services are limited to those linked to the
insurance business, after “legal quote” and taxes.

4.7 Consolidation

The Group MCEV for Swiss Life comprises MCEV results for covered business and IFRS net asset
values for non-covered business.

Covered business comprises all of Swiss Life’s major life, health and pension business as well as
assumed external reinsurance with the exception of Swiss Life Insurance Solutions S.A., which is not
material for MCEV purposes. In the case of France, the remaining operations are sub-consolidated
with their IFRS net asset value and also included in the French covered business.

As described in section 3.1, covered business relates to the operations in:

Switzerland

France

Germany

Luxembourg

Liechtenstein

Singapore

International includes results for Luxembourg, Liechtenstein and Singapore.

The sum of all market consistent embedded values for the market units of the covered business
forms the total MCEV for covered business.

Non-covered business comprises all other entities of the Swiss Life Group that are valued at the
unadjusted IFRS net asset value on a consolidated level, such as the distribution units of
Swiss Life Select or investment management (including CORPUS SIREO), financing and holding
companies. Non-covered business is added to the MCEV results from the covered business to
form the Group MCEV.

4.8 Employee pension schemes and share-based payment programmes

Allowance is made for gains or losses arising from the defined benefit pension plans for Swiss Life’s
own employees. In Switzerland there is a semi-autonomous pension fund with biometric risks
covered by an insurance contract. In other units the major part is covered by insurance contracts.
The remaining part is modelled as commensurate expenses in the projections.

The costs of share-based payment programmes for employees are not included in the MCEV, other
than to the extent that they are allowed for in the local statutory accounts upon which the shareholder
net assets are based. Further information on the costs of share-based payment programmes
is given in the Group’s Consolidated Financial Statements (note 23).